When the SBA's Washington, DC, regional office set out to increase funding to homebased firms around the nation's capital, it took a uniquely aggressive approach: It created a loan program last August specifically for homebased entrepreneurs, one of the most underserved segments of the business credit industry. But there was just one hitch: It couldn't find a single local lender that was willing to make a loan as little as $5,000.

While Washington, DC, lenders were shunning the types of small loans homebased businesses needed, Innovative Bank, an Oakland, California, lender, was busy funding modest credit requests in major western cities, including San Francisco. Joseph Loddo, director of the SBA's Washington, DC, district, recruited Innovative Bank for his Small Office/Home Office (SOHO) lending initiative, which provides guaranteed loans of $5,000 to $25,000 to homebased firms and "small office" companies operating outside the home without employees.

"The applicant is able to get [a loan] within seven days to help them start a business or help them with an existing business," says Loddo. "[Before], when a person who owned a homebased business applied for a loan, they ended up getting a consumer loan, a personal line of credit or a high-interest credit card. We're correcting a mismatch in terms of the sources and uses of funds: a business loan for a business purpose."

Brigitta Toruno was an early recipient. Toruno, owner of UNO Communications, a homebased translation service in Sterling, Virginia, needed financing for a website and marketing. "The program seemed to be a good fit because I wasn't looking for a large loan, and a lot of SBA loans are at least $50,000 to $100,000," says Toruno, 39. While small by industry standards, the $5,000 loan she secured last September provided adequate support. "We work with translators for over 20 languages," she says, "and it's going to help me expand the language base [even further]."

Second-Class Citizens

Loddo's exhaustive search to find a lender for his program underscores the difficulty homebased firms have securing credit. Banks argue that homebased firms are difficult to lend to because they lack business assets and that loans to them are costly. A lender may invest as much time lending $25,000 as $250,000, "but you can't get 10 times as much in rate and fee income," explains Lyle Frederickson, senior vice president of Arizona Business Bank in Phoenix.

Even after the start-up stage, getting financing doesn't necessarily get any easier. Chris Millard, 40, who owns a homebased business in Gilbert, Arizona, with his wife, Linda, received a $100,000 SBA loan, but it wasn't easy. "The SBA process on the bank side is difficult, and they don't like to mess with someone only wanting a $100,000 line of credit to start a business," he says. "When you're getting a $100,000 [loan], you'd think they'd be more interested in loaning you $20,000, when, in reality, that isn't true."

The Millards' firm, DIALYassist, which provides nurses to health-care facilities, had a two-year track record and positive cash flow. Linda, 39, a registered nurse, used the loan to expand the business by providing dialysis services to six area hospitals. Even with revenue from hospital contracts, a profitable history and relationships with medical facilities, the credit line required an SBA guarantee.

Money Hunt

The Burden of Being Homebased

The reality is that banks, even community lenders, are hesitant
to lend to startups. Buying a homebased franchise opportunity may
boost your financing chances, although lending to homebased
entrepreneurs isn't an industrywide practice, says Ginny Young,
president of Orange, California, franchise lender Brava Capital.
Her company doesn't finance homebased borrowers, but she knows
industry peers who are funding cleaning service franchisees, some
of whom may start out as homebased enterprises. "It would be
easier to get that financed than a [homebased] mom-and-pop cleaning
service," she says.

Even so, the franchise lender still needs assurance that a
homebased franchisee has adequate capital levels. Says Young,
"A homebased business is not a lender's dream unless
it's an SBA loan and [the entrepreneurs] have equity in their
house and a good business plan."

Opportunities that homebased entrepreneurs purchase, however,
are a different story. "If it's not a franchise, then
somebody is getting paid by the new business owner to help them do
something, but they're not regulated. It's not an
attractive thing for a lender to bite their teeth into," Young
says.

Any homebased company has the added burden of establishing
legitimacy. But while many lenders have stereotyped homebased
businesses as half-serious endeavors, views are changing. Tim
Jochner, chair of Innovative Bank, formerly requested photographs
of a homebased office. "We always got a picture of a desk and
a computer," he recalls. "If the financial institution is
going to look seriously at the business, it's not going to with
a picture. It's going to be with a business plan. Anything
you've done to show you've made a commitment is a
benefit." For instance, detailing why your business is better
than a competitor's will make an impression, he says. Letters
of intent from customers, client references, a floor plan and
evidence the firm meets licensing requirements further enhance a
credit proposal.

A business plan, meanwhile, serves as the primary link to
financing. "I can talk with my banker personally, but the loan
committee won't have that information unless it's written
in ink," explains Larry Lee, business consultant for the
Missouri Small Business Development Center in Kansas City.

In addition, entrepreneurs should consider a demonstration, says
financial manager Frederick Scenna. Recalling a business plan from
a cell phone product inventor, Scenna says, "When you read
about the product, it just didn't make sense. But when he
brought it in to show us, [I thought], 'That's a very cool
product.'" Scenna, who advises homebased firms in the
Philadelphia area, also recommends joining a local chamber of
commerce, which typically provides free office space for business
meetings.

Cheapskates!

Planning on using your own money to start your business on the
cheap? Read Bootstrapping
Your Business for crucial tips on making your low-cost venture
a success.

All in the Family?

Is it okay to use a family loan to fund a homebased business? As
long as you stay on the IRS' good side.

Calling it a loan doesn't necessarily make it so in the eyes
of the IRS, warns Larry Lee, business consultant for the Missouri
Small Business Development Center in Kansas City. "The IRS has
strong opinions about low- and no-interest loans among family
members. When loans are made below market rate or at no interest,
it could be subject to the federal gift tax."

Stay on the agency's good side by formalizing loan
agreements, which lets you reap tax benefits available to other
business borrowers. Put the deal in writing to demonstrate the
interest is a legitimate business deduction. Says Lee, "Know
the parameters so you don't get yourself into trouble and have
to pay the gift tax on something that truly was a loan."

If the family contribution wasn't intended as a loan,
entrepreneurs can avoid the gift tax by accepting no more than
$10,000 from a parent. "My mother could gift me $10,000,"
Lee explains. "My father could gift me $10,000, my mother
could gift my wife $10,000, and my father could gift my wife
$10,000. There's $40,000 [in business funding] you can do with
a gift."

Digging Deeper

For many aspiring entrepreneurs, family assistance is the most
sensible option. Lee urges loan recipients to draft a business
plan, even if a parent or sibling is writing the check. "Put
together something that everybody understands, including financial
statements, projections and payment details. Make sure you document
the loan terms." Additionally, a life insurance policy to
cover the debt will make a family member more comfortable with
repayment prospects.

Another popular funding source is customer financing. One of
Scenna's clients received a loan from a store owner interested
in selling her product. "If you've got one major customer
selling [your] product or service, [investing in the business can]
only help them," he says. Draft a proposal in advance, and be
prepared to answer questions from customers you approach.

Meanwhile, some entrepreneurs choose to stretch operating funds
by delaying payments to suppliers. "I'm not saying to
stretch payments out to 180 days," Scenna advises, "but
try to get vendors to work with you."

The ability to respond creatively to a credit crisis is crucial
for cash-strapped entrepreneurs. "That's the secret to
small businesses--to structure loans to meet your needs," says
Lee. Indeed, communities are rich in financial resources, including
microloan funds and other programs targeting homebased
entrepreneurs. Major colleges also offer support. Dorothy
Gerstenfeld, 51, started baking Irish soda bread in 1991. She sold
the bread to local stores, eventually supplying a food chain from
her basement bakery. But it wasn't easy for the Havertown,
Pennsylvania, resident. "When I first went in for
financing," she says, "they asked me what my business
plan was. I said I was going to bake a loaf of bread, sell it for
$1, and I was going to do it a lot. They said, 'You're
going to have to be more detailed.'"

Graduate students at the University of Pennsylvania's
Wharton School helped Gerstenfeld draft a business plan. But even
aid from a premier business school couldn't break down barriers
to credit, prompting Gerstenfeld to turn to local programs geared
to businesses like hers. She learned of an economic development
initiative through a friend's husband who served on the
group's board. From that organization, she got a $25,000 loan.
Financing from two other local groups enabled her to restructure
debt by paying off credit card balances she had racked up
renovating her bakery, The Irish Bread Shoppe, now located outside her
home. Gerstenfeld credits those local loans with helping her break
bad financial habits, including her dependence on credit cards.

While not in her case, microloans often serve a dual purpose: A
homebased entrepreneur secures startup funding, and that loan, in
turn, serves as a springboard to conventional financing. "If
things go well, they're going to need a better loan," says
Frederickson of Arizona Business Bank. "What happens is, [a
bank] often pays off the microlender, and [the business] moves into
a bigger loan."

Even a home equity loan used for business funding can make a
statement regarding creditworthiness, Scenna says. "It's a
small step, but a bank can see the business is making
payments."

But don't settle for products geared to nonbusinesses.
"People make the mistake of not opening a business checking
account," Scenna says. "Go in and establish you're a
business."

Plan for Success

Whether you're looking for outside funding or relying on
your own money, you need a business plan to guide you on your path
to success.